Thursday, December 28, 2006

"I can't believe this is happening" is the usual reaction to this series of events:

1. Stockholder with 20% to 49% ownership2. Was an employee but was fired3. Gets no dividends or minimal dividends for his shares4. Gets an offer to buy his shares at what he feels is a terrible price5. Has a shareholder agreement with right of first refusal for the Corporation or other shareholders to purchase his shares at a punishing valuation.

The first reaction is to sue. Let me tell you it is usually a waste of time and almost always a waste of money. After all, you signed the shareholder agreement that states very clearly:

Right of First Refusal: "The Corporation Shall have the power, at its option to purchase any and all of its shares owned and held by any shareholder who should desire to sell……the shareholders shall not assign, transfer, encumber, or in any manner dispose of any or all of the shares of the corporation that may now or hereafter be held or owned by them, and no such shares shall be transferable unless and until such shares have first been offered to the corporation."

It gets worse folks:

……."In the event the Corporation exercises its right of first refusal under the above clauses, the purchase price shall be payable in cash or bank check, and shall be the book value of the shares, exclusive of goodwill, as of the first notice, as determined according to generally accepted accounting principles and shall be binding upon the parties."According to the Coolidge Study "Fixing Value of Minority Interest in a Business" Actual Sales Suggest Discounts as high as 70 percent from what would be considered the fair value of the entire company multiplied by the minority shareholder's percentage ownership.A number of years of experience has demonstrated that it is extremely difficult to find any market for minority interests…

….despite efforts to do so…..On the relatively rare occasions when an offer is made to buy a minority interest, it is almost always for an amount far less than the fiduciary and beneficiary expect to get.

Why does this happen? The majority shareholders whose attorneys drew up the shareholder's agreement certainly balance the scales way in favor of their clients. Secondly, IRS Revenue Ruling 59-60 allows steep discounts when valuing minority interests in privately held companies. The lack of marketability discount can be as high as 40%. A second discount for lack of control for up to 40% can be applied on top of that.

Armed with this knowledge and backed by a favorable shareholder agreement, the majority shareholder is under no compunction to offer anything close to a fair price for the squeezed out minority holder. Below is the sad news that results from this environment as reported by the Coolidge Study of actual minority shareholder buy-outs:

Average sale price was 36% below accounting book valueOnly 20% were at discounts of less than 20%53% sold at discounts ranging from 22% - 48%23% sold at discounts ranging from 54% - 78%

Note: The metric used was accounting book value not fair market value. For most going concerns, net book value is not even close to true market value. Net book value might apply if the company was losing money or making so little money, that the break up value of selling the assets exceeded a valuation based on the earnings capacity of the business. In a company we recently looked at, for example, the net book value was about $3 million. The fair value, however, based on comparables and a discounted cash flow valuation was closer to $10 million. So the best way I can describe these buyout offers is punishing.

Remember the first reaction is the lawsuit. Unless the majority owner does something stupidly oppressive, there are no grounds that can force him to buy your shares at anything other than what is stated in the shareholder agreement. He really does not have to buy your shares at all. He can simply wait you out and pay no dividends, and pass the business down to the next generation. Your family could conceivably get no value for the ownership for a hundred years.Remember, most likely your benefit from being a minority shareholder was that you were employed by the company.

Many squeezed out shareholders try the route of wrongful termination lawsuits. Again, great for the lawyers, not such a sound risk reward decision. Typically they will spend $100,000 in legal fees to recover one year's wages of $150,000. Other than the satisfaction of sticking it to the majority holder, it is pretty much useless. If you think this wrongful termination lawsuit can somehow be used to leverage the majority shareholder into paying fair value for your stock, you are deluding yourself. Unfortunately, the legal counsel you have hired will support your delusion.

We were advising a client that was attempting this ill-fated approach and had been at it for over a year and spent over $100K on a wrongful termination lawsuit when he found us. Our advice went something like this, "Dan, you are focusing on the wrong thing. You are spending all your time and money thinking your wrongful termination lawsuit can somehow benefit your cause to improving the buyout offer. If you win, your one year in salary recovery will just about break you even with your legal expenses. You have been offered $500 K to purchase your 47% interest in a business with an enterprise value of $9 million. Let us help you focus your efforts on chasing the correct pot of gold."

I know what you are thinking. I already know this. I have lived this. Why have I wasted my time reading this article to have you tell me what I already am painfully aware of? OK, maybe I can shine a ray of sunshine. We have developed an investment banking approach to encourage the majority shareholders to allow the minority shareholders to unlock more value for their shares. It involves a great measure of deal making fineness and we are able to help the majority shareholder recognize what's in it for him. Of course, if he does not want to play nicely in the sandbox, we have already set the stage for him to make an error and we then can bring in our legal team and encourage the oppressor to do it the hard way or do it the easy way.

Tuesday, December 26, 2006

Most business owners only sell one business in their lifetime. The results of that sale can have a major impact on the financial future of the family. For most business sales we recommend that the seller engage a professional specializing in business sales to assist. There are two broad categories of professionals that engage in business sales - business brokers and merger and acquisition advisors.

What should the seller be looking for? This article will discuss the type of services offered by both groups and help the business seller decide which professional to use. The first criteria is type of business. Generally, business brokers specialize in "Main Street" types of businesses such as dry cleaners, gas stations, restaurants, and convenience stores. M&A advisors specialize in more B2B types of businesses such as manufacturers, distributors, information technology firms, etc.

Complexity of Transaction - Business Brokers are generally selling to individual buyers that have a finite approach structuring the transaction. The contracts are usually fairly straight forward and the negotiations focus on price, financing, and seller notes. For the Merger & Acquisition Advisors the targeted audience is the corporate buyer with vast experience in acquiring businesses. They employ both an internal legal team and outside council and make the purchase contracts quite complex. The number one goal is protecting the corporation. The contracts are 35 pages of complex legal language and schedules of reps and warranties. The seller will need someone that is familiar in navigating in that environment. Corporations generally send in a due diligence team that is well versed on finding every little wart in a seller company and will attempt to reduce transaction value during the process. The seller will need good advisors to offset these pros.

Exclusivity - because the Business Brokers are targeting individual buyers, their audience is vast so exclusivity is sometimes required and sometimes not required. Business sellers often engage multiple non-exclusive Business Brokers to insure the broadest coverage in presenting their business to the buyer audience. Business Brokers are often part of a network of Business Brokers to help broaden this exposure. Sunbelt Business Brokers and BBN are two very good networks. Merger & Acquisition Advisors require exclusivity because they are targeting corporate buyers and the audience of potential buyers is finite. These corporate buyers have M&A departments or sometimes the president handles the process. If a target is presented to a corporate buyer by more than one professional the credibility immediately drops and the chance of serious interest drops significantly.

Monday, December 11, 2006

Complexity of Transaction - Business Brokers are generally selling to individual buyers that have a finite approach structuring the transaction. The contracts are usually fairly straight forward and the negotiations focus on price, financing, and seller notes. For the Merger & Acquisition Advisors the targeted audience is the corporate buyer with vast experience in acquiring businesses. They employ both an internal legal team and outside council and make the purchase contracts quite complex. The number one goal is protecting the corporation. The contracts are 35 pages of complex legal language and schedules of reps and warranties. The seller will need someone that is familiar in navigating in that environment. Corporations generally send in a due diligence team that is well versed on finding every little wart in a seller company and will attempt to reduce transaction value during the process. The seller will need good advisors to offset these pros.

Thursday, November 02, 2006

As Merger and Acquisition advisors, our goal is to maximize our seller clients' after tax proceeds. The first step is to get the best price from the marketplace by presenting the acquisition opportunity in a competitive bid situation. Having several interested buyers is the most important factor in achieving the best sales price.

However, the nature of the balance sheet of companies with a heavy investments in equipment makes the form of transaction especially important. First rule of thumb in the sale of your privately held business is to have the corporation set up as an S Corp, LLC, or Partnership rather than a C Corp. The reason for this is that buyers prefer an asset purchase versus a stock purchase. If you are structured as a C Corp there is no such thing as long-term capital gains for tax purposes.

So if you have an asset sale of a C Corp, then your gains are taxed first at the applicable corporate tax rate and then taxed again as long term capital gains when the proceeds are distributed to shareholders. This can be particularly harsh to the seller because the sale will normally bump the corporate tax rate in the year of the sale to a much higher rate than it normally is for that company. Goodwill essentially has a basis of $0, so the entire portion of the purchase price allocated to goodwill is a gain. A C Corp, for example, might be taxed at a rate of 34% for the gain versus at 15% for the same gain for a pass through corporate structure like an S Corp.

Buyers prefer an asset purchase for two primary reasons: 1. They want to protect themselves from any hidden liabilities. When you do a stock acquisition, you inherit all assets and all liabilities. 2. The buyer gets to take a step up in basis on all hard assets based on the allocation of purchase price on the asset sale.

Many business sellers, with significant depreciable assets, however, miss a very important issue in transaction structure. They think that they have done everything possible to reduce their taxes because they are an S Corp and do not fight for a stock sale. This incorrect assumption could cost tens of thousands or even hundreds of thousands in after tax proceeds because of depreciation recapture. If your business is heavily equipment intensive and you have naturally taken depreciation, you are subject to depreciation recapture if you do an asset sale of your S Corp.

Let's say that your assets consisting of operating equipment plus office equipment is on the books with accumulated depreciation of, for example, $2,000,000. Then this depreciation that you received as a tax benefit is recaptured in your asset sale and treated as ordinary income for tax purposes. This will most likely push the seller up to the maximum individual tax rate for this portion of transaction value.

If the sale had been a stock sale of the S Corp, there would be no depreciation recapture and the entire gain would be at the individual long-term capital gain rate of the seller. For discussion purposes, let's say your personal income tax rate were 30%, then the asset sale would cause you to pay an additional 15% (difference between personal income tax rate and long term capital gain rate) on the recapture amount of $2,000,000. You would realize $300,000 in additional after tax proceeds by structuring the sale as a stock sale.

So, if your business is an S Corp or an LLC, you have taken the most important step in maximizing your after tax proceeds from your eventual business sale. The next most important step is to get a premium from an asset buyer over a stock buyer to compensate you for after tax proceeds based on depreciation recapture.

Given the impact of taxes in the sale of your business, it is a very sound idea to get your tax accountant involved in the planning process before you start getting offers. You need to be able to compare the different proposals with an eye towards after tax proceeds.

Steve Pierson is a Partner in the Oak Brook, IL office of Seldon Fox, a national accounting and consulting firm. He has over 25 years of experience as a tax professional in public accounting. Steve has a wide range of experience in estate and succession planning, employee benefits and international tax planning for medium-sized businesses and has worked extensively in merger and acquisition transactions.

Steve is a member of the American Institute of Certified Public Accountants and its Tax Legislation Committee and Employee Benefits Committees. He is also a member of the Illinois CPA Society, the Iowa Society of Certified Public Accountants, and serves in many capacities with the Industrial Council of Northwest Chicago and the Profit Sharing Council of America. He has appeared on local cable network telecasts and has written tax related articles for several nationally published magazines.

David Kauppi is a Merger and Acquisition Advisor with Mid Market Capital, Inc. MMC is a private investment banking and business broker firm specializing in providing corporate finance and business intermediary services to entrepreneurs and middle market corporate clients in a variety of industries. The firm counsels clients in the areas of M&A and divestiture, family business succession planning, valuations, business sales and business acquisition. Dave is a Certified Business Intermediary (CBI), a licensed business broker, and a member of IBBA (International Business Brokers Association) and the MBBI (Midwest Business Brokers and Intermediaries). Contact Dave Kauppi at (630) 325-0123, email davekauppi@midmarkcap.com or visit our Web page http://www.midmarkcap.com.

Saturday, September 23, 2006

Business Valuation - Business Brokers specialize in commodity type businesses that have "rule of thumb' valuations that are consistently applied to arrive at a business selling price. There is usually a pretty narrow range of valuations applied to these businesses. Merger & Acquisition Advisors are recommended where there can be a broad interpretation of "strategic value" and rules of thumb do not apply. A high component of Intellectual Property, a unique niche, a hard to penetrate customer base are characteristics that can demand strategic value and purchase prices can vary widely.

Size of Business - Business Brokers specialize in businesses under $1.5 million in revenues and Merger & Acquisition Advisors represent larger businesses or smaller businesses with a high component of technology or intellectual property.

Thursday, September 21, 2006

Remember when you were a child and your mother told you not to touch the hot stove? You couldn't really appreciate that message until you felt the pain shoot through your entire body by way of your finger tips. Oh, now I understand. Sometimes our prospective business sellers get the same kind of message as they pursue the sale of their business to a buyer who approached them with an unsolicited interest to buy.

We often get an inquiry from this business owner because this is usually the only time he will sell a company. He wants advice from us and his position is that he will hire our firm to represent him "if this buyer falls through." Really the best advice we can give him is to engage our firm and let us throw this buyer into the mix of potential buyers that we will uncover. His response is almost always, "I just want to see how this buyer plays out." We have watched this movie that I will call the Single Buyer Syndrome, a hundred times, so let me describe "how it plays out."

· The potential buyer begins an exhaustive courting and informal due diligence process without any offer or Letter of Intent.

· The owner takes his eye off the ball, counting his millions prematurely and devotes less attention than usual in running his business.

· The buyer draws out the process by delaying and rescheduling meetings. He does not treat this process with the same focus and sense of urgency that the seller is now consumed with. Do you know why? The buyer is doing the same dance with 3 or 4 other prospective acquisitions.

· The seller has a difficult time getting the buyer to put some terms and conditions in writing. If he does, it provides a good deal of wiggle room to adjust his offer as due diligence progresses.

· The process seems to stretch on and on as more meetings get delayed and rescheduled.

· Finally, the seller gets aggravated and begins to put some time limits and demands on the buyer.

· The buyer now gathers his team of accountants, attorneys, operations managers, and others to tear apart your company.

· This team finds all kinds of problems that they use to justify lowering the offer and increasing the reps and warranties and increasing the amount of hold back in an escrow account. They also bring up the requirement for owner financing for the first time.

· The buyer has carved a significant chunk out of his offer while using all his experts to back him up. The seller is now 6 months into the process and the buyer knows that you have a great deal of skin in the game. He is counting on the seller to just cave and weakly counter because this process has just worn him down.

· If the seller relents, he likely has had his original offer reduced by 20% or more. The original offer, however, started below what the business was actually worth. If he sells under these circumstances, he likely will realize 30% or more below what a fair market competitive bid situation would produce.

· The other response from the seller is to be insulted and blow up the deal, leaving his company in a weaker state than when this whole process began. The seller focused much of his own energy on this process rather than running his business.

· The buyer moves on to his next acquisition candidate with the same M.O.

Unfortunately, the story does not end here. Many owners will go through this process more than once. It can stretch on for years because he can normally process only one buyer at a time. The only way to insure the right selling price is to throw these buyers into a formal M&A process. When you do, these buyers usually drop out of the running pretty quickly because they want to find a bargain. You worked too long and too hard to suffer from Single Buyer Syndrome and sell your company for a discount.

If you are an entrepreneur with a small food or beverage company looking to take it to the next level, this article should be of particular interest to you. Your natural inclination may be to seek venture capital or private equity to fund your growth, but that might not be the best path for you to take. We have created a hybrid M&A model designed to bring the appropriate capital resources to you entrepreneurs. It allows the entrepreneur to bring in smart money and to maintain control. We have taken the experiences of a beverage industry veteran, a food industry veteran and an investment banker and crafted a model that both large industry players and the small business owners are embracing.

I recently connected with two old college mates from the Wharton Business School. We are in what we like to call, the early autumn of our careers after pursuing quite different paths initially. John Blackington is a partner in Growth Partners, a consulting firm that advises food and beverage companies in all aspects of product introduction and market growth. You might say that it has been his life’s work with his initial introduction to the industry as a Coke Route driver during his college summer breaks. After graduation, Coke hired John as a management trainee in the sales and marketing discipline. John grew his career at Coke and over the next 25 years held various positions in sales, marketing, and business development. John’s entrepreneurial spirit prevailed and he left Coke to consult with early stage food and beverage companies on new product introductions and strategic partnerships.

Steve Hasselbeck is now a food industry consultant after spending 27 years with the various companies that were rolled up into ConAgra. His experience was in managing products and channels. Steve is familiar with almost every functional area within a large food company. He has seen the introduction and the failed introduction of many food industry products.

John’s experience at Coke and Steve’s experience at ConAgra led them to the conclusion that new product introductions were most efficiently and cost effectively the purview of the smaller, nimble, low overhead company and not the food and beverage giants.

Dave Kauppi is now the president of MidMarket Capital, a M&A firm specializing in smaller technology based companies. Dave got the high tech bug early in his business life and pursued a career in high tech sales and marketing. Dave sold or managed in computer services, hardware, software, datacom, computer leasing and of course, a Dot Com. After several experiences of rapid accent followed by an even more rapid decent as technologies and markets changed, Dave decided to pursue an investment banking practice to help technology companies.

Dave, John, and Steve stayed in touch over the years and would share business ideas. In a recent discussion, John was describing the dynamics he saw with new product introductions in the food and beverage industry. He observed that most of the blockbuster products were the result of an entrepreneurial effort from an early stage company bootstrapping its growth in a very cost conscious lean environment. The big companies, with all their seeming advantages experienced a high failure rate in new product introductions and the losses resulting from this art of capturing the fickle consumer were substantial. When we contacted Steve, he confirmed that this was also his experience. Don’t get us wrong. There were hundreds of failures from the start-ups as well. However, the failure for the edgy little start-up resulted in losses in the $1 - $5 million range. The same result from an industry giant was often in the $100 million to $250 million range.

For every Hansen Natural or Red Bull, there are literally hundreds of companies that either flame out or never reach a critical mass beyond a loyal local market. It seems like the mentality of these smaller business owners is, using the example of the popular TV show, Deal or No Deal, to hold out for the $1 million briefcase. What about that logical contestant that objectively weighs the facts and the odds and cashes out for $280,000?

As we discussed the dynamics of this market, we were drawn to a merger and acquisition model commonly used in the technology industry that we felt could also be applied to the food and beverage industry. Cisco Systems, the giant networking company, is a serial acquirer of companies. They do a tremendous amount of R&D and organic product development. They recognize, however, that they cannot possibly capture all the new developments in this rapidly changing field through internal development alone.Cisco seeks out investments in promising, small, technology companies and this approach has been a key element in their market dominance. They bring what we refer to as smart money to the high tech entrepreneur. They purchase a minority stake in the early stage company with a call option on acquiring the remainder at a later date with an agreed-upon valuation multiple. This structure is a brilliantly elegant method to dramatically enhance the risk reward profile of new product introduction. Here is why:

For the Entrepreneur: (Just substitute in your food or beverage industry giant’s name that is in your category for Cisco below)

The involvement of Cisco – resources, market presence, brand, distribution capability is a self fulfilling prophecy to your product’s success.For the same level of dilution that an entrepreneur would get from a VC, angel investor or private equity group, the entrepreneur gets the performance leverage of “smart money.” See #1.The entrepreneur gets to grow his business with Cisco’s support at a far more rapid pace than he could alone. He is more likely to establish the critical mass needed for market leadership within his industry’s brief window of opportunity.He gets an exit strategy with an established valuation metric while the buyer helps him make his exit much more lucrative.As an old Wharton professor used to ask, “What would you rather have, all of a grape or part of a watermelon?” That sums it up pretty well. The involvement of Cisco gives the product a much better probability of growing significantly. The entrepreneur will own a meaningful portion of a far bigger asset.

For the Large Company Investor:

Create access to a large funnel of developing technology and products.Creates a very nimble, market sensitive, product development or R&D arm.Minor resource allocation to the autonomous operator during his “skunk works” market proving development stage.Diversify their product development portfolio – because this approach provides for a relatively small investment in a greater number of opportunities fueled by the entrepreneurial spirit, they greatly improve the probability of creating a winner.By investing early and getting an equity position in a small company and favorable valuation metrics on the call option, they pay a fraction of the market price to what they would have to pay if they acquired the company once the product had proven successful.

Dean Foods utilized this model successfully with their investment in White Wave, the producer of the market leading Silk Brand of organic Soy milk products. Dean Foods acquired a 25% equity stake in White Wave in 1999 for $4 million. While allowing this entrepreneurial firm to operate autonomously, they backed them with leverage and a modest level of capital resources. Sales exploded and Dean exercised their call option on the remaining 75% equity in White Way in 2004 for $224 million. Sales for White Way were projected to hit $420 million in 2005.

Given today’s valuation metrics for a company with White Way’s growth rate and profitability, their market cap is about $1.26 Billion, or 3 times trailing 12 months revenue. Dean invested $5million initially, gave them access to their leverage, and exercised their call option for $224 million. Their effective acquisition price totaling $229 million represents an 82% discount to White Wave’s 2005 market cap.

Dean Foods is reaping additional benefits. This acquisition was the catalyst for several additional investments in the specialty/gourmet end of the milk industry. These acquisitions have transformed Dean Foods from a low margin milk producer into a Wall Street standout with a growing stable of high margin, high growth brands.

Dean’s profits have tripled in four years and the stock price has doubled since 2000, far outpacing the food industry average. This success has triggered the aggressive introduction of new products and new channels of distribution. Not bad for a $5 million bet on a new product in 1999. Wait, let’s not forget about our entrepreneur. His total proceeds of $229 million are a fantastic 5- year result for a little company with 1999 sales of under $20 million.

MidMarket Capital has created this model combining the food and beverage industry experience with the investment banking experience to structure these successful transactions. MMC can either represent the small entrepreneurial firm looking for the “smart money” investment with the appropriate growth partner or the large industry player looking to enhance their new product strategy with this creative approach. This model has successfully served the technology industry through periods of outstanding growth and market value creation. Many of the same dynamics are present in the food and beverage industry and these same transaction stru7ctures can be similarly employed to create value.

MidMarket Capital, Inc., MMC is an M&A Advisory firm specializing in providing corporate finance and business broker services to entrepreneurs and middle market corporate clients in the food, beverage, and select niche markets. The firm counsels clients in the areas of mergers, acquisitions and divestitures, private placements of debt and equity, valuations, corporate growth and turnarounds. Dave began Mergers and Acquisitions practice after a twenty-year career within the financial and information technology industries. Steve brings a broad background including new item introductions, trade and customer marketing strategy, pricing, and distribution for traditional grocery retailers as well as the alternate or non-traditional grocery accounts. John started GBS, a beverage industry consulting firm after a 25 year career with Coca Cola. Contact Dave Kauppi at (630) 325-0123, davekauppi@midmarkcap.com or Steve Hasselbeck (630) 415-6577 shasselbeck@midmarkcap.com or John Blackington (214) 215-4444 http://www.midmarkcap.com

Tuesday, April 18, 2006

For the past 20 years you have built your business. Your company has become part of your identity. Even when you are not at work, you are working, thinking, planning. You never stop. If you sell you are leaving behind much more than a job. In this article we will discuss some signs that might indicate that it is time to exit your business.

1. Late in your working life you are faced with a major capital requirement in order for your company to maintain its competitive position.2. A large competitor is taking market share away from you at an accelerating pace.3. Your legacy systems, production capabilities, or competitive advantage has been "leap frogged" by a smaller, nimble, entrepreneurial firm.4. A major company in a related industry just acquired a direct competitor.5. Your fire to compete at your top level is not burning as brightly as it once did.6. Your kids are not interested or are not capable of running the business.7. You have had a health scare and have decided to smell the flowers.8. You have lost a major client of a key employee.9. The market is hot and you decide to take some chips off the table for asset diversification.10. You exit in an orderly fashion and from a position of strength as you intended.

Monday, April 10, 2006

Our industry is misunderstood at the lower end of the market. The fortune 1000 companies would not consider a capital event without engaging an investment banking firm. Smaller companies seeking a sale need the same kind of services, but with a fee structure that is more size appropriate.When I see a couple of firms with a powerful marketing reach engaging in practices that hurt our industry, it ticks me off. Most of the firms that service the lower end of the market are hardworking, honorable people seeking to provide excellent value. Many of these firms are members of the International Business Brokers Association, IBBA. This organization sets standards for business practices and ethical behavior. They also have established an industry certification, the CBI, Certified Business Intermediary.So as you consider the company you want to engage to sell your business, he is what you look for:1. No big up-front fees, but monthly fees.2. No promises of foreign buyers for companies under $30 million.3. A period of exclusivity from 12 to 24 months, not 5 years.4. A firm that actively sells your company using direct calling into targeted buyers, and not simply posting on business for sale Web Sites and mass mailings.5. A firm that tracks and reports their sales progress to you bi-weekly with a status or pipeline report.6. A firm that is a member of a professional association like IBBA or M&A Source or a local or regional business broker network like MBBI.7. A firm that at the appropriate time will introduce you telephonically to two of their reference clients whose business they successfully sold.8. A firm that has a principal that has passed their industry testing and has been issued a CBI designation.9. An Advisory firm that has experience selling companies in your industry and understands who the targeted buyers are, the right contact, and the industry nomenclature. Finally they should understand your industry's unique valuation metrics and deal structures.This is the most important contractor or vendor you will ever hire for your business. Your economic future depends on the success of this engagement. Think of other major purchase decisions you have made for your company. Be every bit as rigorous in making your selection of an M&A advisor.

The final issue I would like to discuss, I would not call an official red flag, but maybe a "nice to have." Have you sold any companies in my industry? Sometimes, your business is unique and there has not been much M&A activity and you will have to weigh other factors more heavily. The advantages in using business broker or merger and acquisition firm that has industry experience are that it both speeds up the sale process and it increases the likelihood of a completed transaction. An M&A firm that has your industry experience will already have their database of potential buyers established. They know the right contact person and these prospects know them and actually take their calls. This alone can reduce the sales cycle by as much as 90 days. Another big advantage of industry experience is your advisor will understand valuation multiples and deal structures unique to your industry. That can be invaluable when the buyer is attempting to grind down your selling price. Industry credibility is very important when your advisor gets the CEO of a targeted buyer on the phone and has exactly 30 seconds to establish buyer interest. It really helps if you speak his language. Our clients in information technology and healthcare have found industry specialization to be of significant value.

Selecting a business broker or an M&A firm to represent your company for sale can be a confusing and difficult process. This posts one of the potential pitfalls.

Last week I got a call from a business owner who had decided to sell his business. He and his partners were beginning the beauty contest phase of selecting a firm to represent them in the sale. His partners had begun discussions with a merger and acquisition advisory firm. He had followed up with this firm prior to calling us and had questioned them on several issues. He shared his findings with me and asked my opinion. Generally I subscribe to my old IBM training and will not disparage a competitor, however, some of the answers were alarming to me so I elected not to withhold my opinions.

The first red flag was that this competitor required a large up-front engagement fee. I certainly have no problem with Merrill Lynch or Goldman Sachs charging their up front fees to their fortune 1000 clients. These firms are a proven commodity with a proven process. Their clients feel confident that a liquidity event will result from their work. A monthly fee is a more accommodating approach for smaller clients whose cash flow would be strained by a large up-front payment.

We have had many prospective clients approach us after unfortunate experiences with these big up-front fees. In one recent case, we were brought into a holding company who had acquired one of our sell side clients. Another division had engaged an M&A firm to sell one of their subsidiaries. After a $40,000 up-front payment and over four months, not one prospect had been contacted. Another common result for clients of these up-front fee firms is a beautiful, bound, 40-page book of boilerplate compiled by a junior level analyst. Unless this is accompanied by a concerted sales and marketing effort, this book will become a very expensive coffee table book.

Monday, March 13, 2006

Question posed to Karl Straub, Senior VP and General Manager, PER-SE TECHNOLOGIES Resource Management Business Unit - Hospital Services Division, "Karl what has been your experience when a selling company is represented by a Merger and Acquisition Advisory Firm?""We grow our business both organically and through strategic acquisitions. We find that when an experienced M & A advisor represents the seller it increases the likelihood that a transaction will be successfully completed. A seller's advisor can act as an intermediary to help keep his client's value expectations in-line with the market, provide valuable deal structure recommendations, and work with his client and our business team to settle business issues before we bring in the attorneys for final legal review."

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com http://www.midmarkcap.com/Dave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Monday, February 27, 2006

If you are a minority interest shareholder in a privately held company you need to be aware of some warning signs of bad behavior on the part of the majority shareholders. If you find yourself in a Squeeze-Out, you may have some legal remedies, but you face an expensive and uphill battle. This article describes, unfortunately, a fairly common situation.

If you are a minority interest shareholder in a privately held company, watch out for these Red Flags:

The majority shareholder grants himself a salary and benefit package way above the going market rate - in effect granting him a constructive dividend

No dividends are paid from a very profitable company

He begins using the company as his personal piggy bank

You are removed from your Board of Director position

Company financial information is withheld from you

You are fired from the company without cause

If one or of these events has occurred, watch out! The next shoe to fall is an unsolicited offer to buy out your shares. The offer price seems unusually low. If you protest, expect the buyer to refer you to the shareholder agreement where the corporation has the right of first refusal to buy your shares at net book value. That number, for most companies, values your shares at pennies on the dollar.

You next get the speech that the majority shareholder will never sell his company. The price I am offering is all the company can afford. We are not going to pay any dividends. This is a risky market and the business could falter. This is the only way you are going to get any liquidity for your stock.

In family situations this can be devastating. It is usually the result of children inheriting the business through either gifting or from dad's estate. Because 90% of his net worth is tied up in the business, to be fair, he has to give essentially equal shares to all of his children. Maybe Son A and Daughter C work in the business and Son B and Daughter D do not. Dad gives 30% ownership to each sibling in the business and 20% to each sibling that is not involved.The two siblings running the business begin to blur the lines between stock ownership and employment. They develop an attitude of entitlement. Those other two siblings did nothing to grow this business. The company-involved owners begin to view their stock as more valuable than the other siblings. Their salaries and perks get bloated and no dividends get paid to the other shareholders. I don't think Bill Gates refuses to pay dividends to his stockholders because "they did nothing to grow this business".

Here is where the problems begin. Dad has left a company shareholder agreement in place that makes it almost impossible for a minority shareholder to get a fair price for their company stock. Dad has also done a great job of estate tax planning, using all available legal means to minimize the gift and estate taxes resulting from transferring ownership to the next generation.The most common approach is to form two or more Family LLC's that would be the owners of the company stock and then dad gives a gift of an equal share of the LLC's to each heir. This effectively breaks the company into several minority interest ownership positions. Now a qualified valuation firm is hired to value the LLC's. All of a sudden the value of the company evaporates.

Here is how it works. Let's say that Johnson Corporation would command a price of $9 million if an M&A firm in a competitive market transaction sold it. However, Johnson Corporation is 33% minority owned by three different Family LLC's. The valuation firm values the company stock held in each LLC not at $3 million, but at $3 million less a 40% lack of control discount, or $1.8 million. Next they apply a lack of marketability discount (after all, the shareholder agreement restricts the sale to outside investors) and the valuation drops further to $1,080,000. Now the three LLC's are added back together and the $9 million company is valued at $2,240,000 for "Gift and Estate Tax Purposes".

This document is submitted as supporting documentation with the gift or estate tax filing - very official. The IRS examiner reviews it and accepts it as the basis for the tax payment. Two years later the two siblings running the company approach the other two siblings and present them with a buy-out offer accompanied with this valuation that was filed and accepted by the IRS. Son B owns 20% of the company stock through his interests in the three Family LLC's. He is offered 20% of $3,240,000 or $648,000 for his company ownership. The fair value is 20% of $9,000,000 or $1,800,000.

He has no idea what the company is worth and has never been given any information of earnings or comparable M&A transactions in the market. Even though the valuation has on its cover, "For Gift and Estate Tax Purposes Only," he does not understand the implications of that standard blanket disclaimer.

His natural reaction is that this document was filed with the IRS and accepted. It must be pretty close to what my stock is worth. If someone were not involved in this area of law professionally (estate tax attorney, estate planner, tax accountant, valuation firm, investment banker, or IRS agent), they would likely accept this as the accurate value of their shares. I tell clients that it would be like being handed an MRI of my heart and being asked to interpret it. I am not experienced in this very specialized area and therefore would depend on my doctor to interpret it for me.

A nationally recognized and credentialed valuation firm complete with 50 pages of discounted cash flow and other sophisticated analysis and data completed this valuation. It next passed the scrutiny of the IRS examiners. Now a family member is interpreting it for you. What conclusion are your supposed to draw?

Unfortunately this happens all the time. Usually it results in the non-involved siblings having a standard of living that is significantly different than what dad had intended when he equally divided his estate among all his children. Dad would not approve.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com http://www.midmarkcap.com/Dave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Saturday, February 25, 2006

Your ability to integrate the new economy through your company's Web Site into your business could provide huge returns when you sell your company.

Business owners often contact us requesting an introductory meeting. They are contemplating the near to intermediate term exit from their business. The meetings generally have two major themes: 1. The beauty contest – they want to interview merger and acquisition firms or business brokers to evaluate their qualifications and process in comparison with other competitors and 2. Preparation for Sale – what should we be doing in anticipation of putting our company on the market?

One of the questions I ask on their first phone call is, "What is your Web Site address?" As a potential advisor, I want to go to their site and find out all I can about their business in preparation for the first meeting. If they respond that they do not yet have a Web Site, I already know what my top priority recommendation is in response to their questions on preparing their business for sale.

The spectacular growth of the Internet powerhouses Google, Yahoo, and Ebay should convince you that the Internet is dramatically changing the way America does business. Think about your own buying habits. It is so convenient to type in a few key words and have a world of choices presented on your computer screen. Try this simple exercise. Do a Google or Yahoo search of some key words or phrases that a potential customer of your business might use if they were searching for a vendor of your products or services. Does your web site come up? Click on some of the sites that come up on the first page of the search. Look at their Web Sites. Do you think they are getting additional business based on their search result success? Bet on it!If you had asked me three years ago if I thought that a business owner would hire our firm based on finding us on the Internet, I would have said no. In the last quarter we have gotten two new engagements based on a client’s initial Internet search. It does not matter what type of business you run, you simply must have a Web presence. At the very least your company should have a Web Site consisting of "brochure ware". That is very simple and inexpensive to implement. Brochure ware is simply taking your company’s collateral material and putting it up on a Web Site. If a buyer is evaluating several potential acquisitions, the absence of a Web Site will be perceived as a negative.

If you are able to integrate your Web Site into your customer service, ordering, order status, documentation, training, etc., (eCommerce) your investment could pay huge dividends when you sell your business. The new reality is that it is considerably more cost effective to conduct eCommerce than traditional commerce. The big payoff comes when potential buyers perceive your eCommerce initiative as scaleable. My translation of this over used term is that a large increase in sales can be accomplished with a small increase in fixed costs. Buyers pay for the potential you create in your business. Buyers make acquisitions to grow and if that growth can be accomplished with improving margins, your selling price will go up.In real estate, the largest dollar for dollar return on investment for the home seller is their expenditure on landscaping. As a potential business seller, think of your investment in a Web presence in the same light.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions.

Thou shall be flexible and open to creative deal structure. Everything is a negotiation. You may have in mind that you want a gross purchase price of $13 million and all cash at close. Maybe the market does not support both targets. You may be able to get creative in order to reach that purchase price target by agreeing to carry a seller note. If the sale process produces multiple bids and the best one is $11.3 million cash at close. You may counter with a 7-year seller balloon note at 8% for $3 million with $10 million cash at close. If the buyer is a solid company, that may be a superior outcome than your original target because the best interest return you can currently get on your investments is 4%. Be flexible, be creative, and use your team to negotiate the hard parts and preserve your relationship with the buyer.You may have spent your life's work building your business to provide you the income, wealth creation, and legacy that you had planned and hoped for. You prepared and were competitive and tireless in your approach. You have one final act in your business. Make that your final business success. Exit on purpose and do it from a position of strength and receive the highest and best deal the market has to offer.

Thou shall disclose, disclose, disclose, and do it early. A seemingly insignificant minor negative revealed early in the process is an inconvenience, a hurdle, or a point to negotiate around. That same negative revealed during negotiations, or worse yet, during due diligence, becomes, at best, a catalyst for reexamining the validity of every piece of data to, at worse, a deal breaker. No contract in the world can cover every eventuality if there is not a fundamental meeting of the minds and a trust between the two parties. Unless you are lucky enough to get an all cash offer without any reps and warranties, you are going to be partnered with your buyer for some period in the future. Buyers try to keep you on the hook with reps and warranties that last for a few years, employment contracts, or non-competes that last, escrow funds, seller notes, etc. These all serve a dual role to reduce the risk of future surprises. If future material surprises occur, buyers tend to be punitive in their resolution with the seller. Volunteer to reveal your company's warts early in the process. That will build trust and credibility and will ensure you get to keep all of the proceeds from your sale.

Thou shall be reasonable in my expectations on sales price and terms. The days of irrational exuberance are over. Strategic buyers, private equity groups, corporate buyers, and other buyers are either very smart or do not last very long as buyers. I hate rules of thumb, but generally there is a range of sales prices for similar businesses with similar growth profiles and similar financial performance. That being said, however, there is still a range of selling prices. So, for example, let's say that the sales price for a business in the XYZ industry is a multiple of between 4 and 5.5 times EBITDA. Your objective and the objective of a good M&A advisor is to sell your business at the top end of the range under favorable terms. In order for you to sell your business outside of that range you must have a very compelling competitive advantage, collection of intellectual property, unusual growth prospects, or significant barriers to entry that would justify a premium purchase price. If you think about the process of detailing your car before you offer it for sale, a good M&A advisor will assist you in that process for your business. Let's say, for example, that 4 to 5.5 multiple from above was the metric in your industry and you had an EBITDA for the last fiscal year of $2.5 million. Your gross transaction proceeds could range from $10 million to $13.75 million. A skilled M&A firm with a proven process can move you to the top of your industry's range. The impact of hitting the top of the sales price range vs. the bottom more than justifies the success fee you pay to your M&A professionals.

Thou shall engage other professionals that have experience in business sale transactions. You may have a great outside accountant that has done your books for years. If he has not been involved in multiple business sales transactions, you should consider engaging a CPA firm that has the experience to advise you on important tax and accounting issues that can literally result in swings of hundreds of thousands of dollars. What are the tax implications of a stock purchase versus an asset purchase? A lower offer on a stock purchase may be far superior to a higher offer on an asset purchase after the impact of taxes on your realized proceeds. Is the accountant that does your books qualified to advise you on that issue? Would your accountant know the best way to allocate the purchase price on an asset sale between hard assets, good will, employment agreements and non-compete agreements? A deal attorney is very different from the attorney you engage for every day business law issues. Remember, each element of deal structure that is favorable to the seller for tax or risk purposes is generally correspondingly unfavorable to the buyer, and vice versa. Therefore the experienced team for the buyer is under instructions to make an offer with the most favorable tax and reps and warranties consequences for their client. You need a professional team that can match the buyer's team's level of experience with deal structure, legal, and tax issues.

Thou shall hire a Mergers and Acquisitions firm to sell my business. You improve your odds of maximizing your proceeds while reducing the risk of business erosion by hiring a firm that specializes in selling businesses. A large public company would not even consider an M&A transaction without representation from a Merrill Lynch, Goldman Sachs, Solomon Brothers or other high profile investment banking firm. Why? With so much at stake, they know they will do better by paying the experts. Companies in the $3 Million to $50 Million range fall below their radar, but there are mid market M&A firms that can provide similar services and process. Generally when you sell your business, it is the one time in your life that you go through that experience. The buyer of the last company we represented for sale had previously purchased 25 companies. The sellers were good business people, knew their stuff, but this was their first and probably last business sale. Who had the advantage in this transaction? By engaging a professional M&A firm they helped balance the M&A experience scales.

Thou shall get multiple buyers interested in my business. The "typical" business sale transaction for a privately held business begins with either an unsolicited approach by a competitor or with a decision on the part of the owner to exit. If a competitor initiates the process, he typically isn't interested in over paying for your business. In fact, just the opposite is true. He is trying to buy your business at a discount. Outside of yourself there is no one in a better position to understand the value of your business more than a major competitor. He will try to keep the sales process limited to a negotiation of one. In our mergers and acquisitions practice the owner often approaches us after an unsolicited offer. What we have found is generally that unsolicited buyer is not the ultimate purchaser, or if he is, the final purchase price is, on average 20% higher than the original offer. If the owner decides to exit and initiates the process, it usually begins with a communication with a trusted advisor - accountant, lawyer, banker, or financial advisor. Let's say that the owner is considering selling his business and he tells his banker. The well- meaning banker says, "One of my other customers is also in your industry. Why don't I provide you an introduction?" If the introduction results in a negotiation of one, it is unlikely that you will get the highest and best the market has to offer.

Thou shall keep my eye on the ball. A major mistake business owners make in exiting their business is to focus their time and attention on selling the business as opposed to running the business. This occurs in large publicly traded companies with deep management teams as well as in private companies where management is largely in the hands of a single individual. Many large companies that are in the throws of being acquired are guilty of losing focus on the day-to-day operations. In case after case these businesses suffer a significant competitive downturn. If the acquisition does not materialize, their business has suffered significant erosion in value. For a privately held business the impact is even more acute. There simply is not enough time for the owner to wear the many hats of operating his business while embarking on a full-time job of selling his business. The owner wants the impending sale to be totally confidential until the very last minute. If the owner attempts to sell the business himself, by default he has identified that his business is for sale. Competitors would love to have this information. Bankers get nervous. Employees get nervous. Customers get nervous. Suppliers get nervous. The owner has inadvertently created risk, a potential drop in business and a corresponding drop in the sale price of his business.

Thou shall prepare my business for sale. Now that you are all excited about the fun things you'll do once you exit your business, it's now time to focus on the things that you can do to maximize the value of your business upon sale. This topic is enough content for an entire article, however, we will briefly touch upon a couple of important points. First, engage a professional CPA firm to do your books. Buyers fear risk. Audited or reviewed financial statements from a reputable accounting firm reduced the perception of risk. Do not expect the buyer to give you credit for something that does not appear in your books. If you find that a large percentage of your business comes from a very few customers, embark on a program immediately to reduced customer concentration. Buyers fear that when the owner exits the major customers are at risk of leaving as well. Start to delegate management activities immediately and identify successors internally. If you have no one that fits that description and you have enough time, seek out, hire and train that individual that would stay on for the transition and beyond. Buyers want to keep key people that can continue the momentum of the business. Analyze and identify the growth opportunities that are available to your business. What new products could I introduced to our existing customer base? What new markets could utilize our products? What strategic alliances would help grow my business? Capture that in a document and identify the resources required to pursue this plan. Buyers will have their own plans, but you'll increase their perception of the value of your business through your grasp of the growth opportunities.

Thou shall to be prepared personally. We all create business plans both formally and informally. We all plan for vacations. We plan our parties. We need to plan for the most important financial event of our lives, the sale of our business. Typically a privately held business represents greater than 80% of the owner's net worth. Start out with your plans of how you want to enjoy the rewards of your labor. Where do you want to travel? What hobbies have you been meaning to start? What volunteer work have you meant to do? Where do you want to live? What job would you do if money were not in issue? You need to mentally establish an identity for yourself outside of your business.

Thou shall not wait too long. Have you ever heard, "I sold my business to early?" Compare that with the number of times you've heard somebody say, "I should have sold my business two years ago." Unfortunately, waiting too long is probably the single biggest factor in reducing the proceeds from the sale of a privately held business. The erosion in business value typically is most pronounced in that last year before exiting. The decision to sell is often times a reactive decision rather than a proactive decision. An individual who spends 20 years running their business and controlling their outcomes often behaves differently in the exit from his business. The primary reasons for selling are events such as a serious health issue, owner burnout, the death of a principal, general industry decline, or the loss of a major customer. Exit your business from a position of strength, not from the necessity of weakness. Don't let that next big deal delay your sale. You can reward yourself for that transaction you project to close with an intelligently written sale agreement containing contingent payments in the future if that event occurs.

Thursday, February 23, 2006

The letter of intent is an essential step in facilitating the sale of a business. The purpose is to establish the economic framework for buyer and business seller to move to the due diligence phase. It basically says that with all the available information I have thus far seen and if that all stands the scrutiny of due diligence, I am willing to buy your business for X dollars under Y payment terms. It is however, non- binding pending the execution of mutually acceptable purchase agreements.If I am a seller, I am going to insist that I have this letter establishing the economics of the deal before I agree to allow my company to be turned inside out with buyer staff and advisors. If, as the seller, I want $5 million and the LOI specifies $4.5 million, I am going to attempt to negotiate up before I counter sign this letter. If I am still short on price and terms, I continue to sell the company to other interested buyers.If I am the buyer, I want the seller to commit to my economic parameters before I spend thousands going through due diligence. The other important element of the LOI from the buyer’s perspective is exclusivity. The buyer will lock up this company for a period of from 30 days to 90 days to complete their due diligence and execute mutually agreeable definitive purchase agreements. That means that in return for the time, effort and expense of due diligence, the seller and his business broker or merger and acquisition advisor are not allowed to actively market the business to other interested parties.If you are the seller and you get your LOI, don’t celebrate yet. Make sure the financials that the buyer is analyzing to come up with his offer are professionally done using GAAP. Normally a measuring point is established in the LOI with those financials for net working capital. There will be an adjustment made to the transaction value (post closing adjustments) depending on the new net working capital balance post close.If the buyer is looking at sales forecasts prior to submitting his LOI, make sure they are conservative and accurate. If you have some major sales losses or the pipeline moves to the right (they always do) some buyers may attempt to call that a material adverse change and look for an adjustment in purchase price.Finally, the LOI is normally a three to seven page document without a lot of legal boilerplate. The purchase agreements that follow will take care of that. So expect 30 pages or more. Focus your efforts on the economic parameters and conserve your legal budget. You will need your attorney most for his help with the purchase agreements.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Monday, February 20, 2006

If you are a minority interest shareholder in a business, it is critical you understand what you are signing when you execute the shareholder agreement. If you have already signed one and are looking to exit the company and cash in your stock at fair value - good luck.

Normally shareholder agreements or buy sell agreements are written by the majority shareholder's very smart and experienced attorney and are totally favorable to the majority shareholder/Corporation. The minority interest shareholders are required to sign these agreements and often do not understand all the implications of what they are signing until it is too late. I will define too late as when they are trying to exit the business and get a liquidity event at a value that is reasonably close to the value of the company multiplied by their percentage ownership in the company.

There are several approaches that we see used in determining the Purchase Price for shares of selling shareholders. The most common is Net Book Value. What net book value means is that you take all the assets and subtract all the debts and you get the shareholder equity or net book value. To the untrained observer that would seem fair and logical. In reality, it is simply an accounting presentation and generally has no relationship to what the business is really worth. An example is a company that owns a prime piece of real estate for their factory and the neighborhood has become hot. That facility was acquired in 1968 for $2 million with half of the value in the building and half in the land. The building has been depreciated down to $400,000 and the land stays on the books at $1 million. A fair market value of the facility is now $8 million and yet its net book value is recorded at $1.4 million.

Another weakness in this approach (for the minority, not the majority shareholders) is that there is no value placed on the going concern or the good will. Let's say you are software company with 300 installed accounts, a cutting edge application and are growing at 30% per year. They might have 10 depreciated servers, some used office furniture and virtually no other hard assets. Their book value is $87,000. The true fair value for the company, according to a strategic buyer who may really want this company might be $25 million. The book value is not even in the same zip code as the true value of the business.

Sometimes the parties agree on an approach that is based on an appraisal from a qualified valuation firm. If you are a minority holder you are beaten before you have even started. Standard valuation practice allows for a "lack of marketability discount" of up to 40% and a "lack of control" discount of up an additional 40%. Say good bye to your ability to compel the corporation to give you fair value.

The best way is to establish a valuation formula that can be applied when the agreement is put in place and also at a date ten years into the future. My favorite is an EBITDA multiple. A safe bet would be a 4 X EBITDA to establish the value of the entire company and then each shareholder would be able to get their ownership % times the company value. The company should have the ability to pay this out over 5 years at prime so that the event does not disrupt the company's capital structure. One note of caution, most small companies do everything possible to push down earnings which would depress the value of the enterprise using EBITDA. An example is salaries for owners and key employees that are above market (a constructive dividend). We use the term normalized EBITDA or Adjusted EBITDA to add back things like excess salaries, owner perks, and other expenses that would not be allowed if the company were a division of a large public company.

I know what you are thinking. I already have one of these agreements in place, am a minority interest shareholder, I am leaving the company, and I want fair value for my stock. Unless you have the evidence, the stomach, and most importantly the deep pockets to pursue a shareholder oppression lawsuit, you are pretty much out of luck. We have developed some approaches that have been reasonably successful in improving the outcomes of these unfortunate stockholders, but that is the subject of a future article.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Saturday, February 18, 2006

Some pundits estimate that about 70% of company acquisitions do not produce the returns anticipated by the buying company. Let's look at a case study of how a strategic seller and a strategic buyer came together to create a winning M&A transaction.

In our M&A practice we strive to align the right buyer with the seller and combine that with the appropriate deal structure. If we can do that while keeping the deal process flowing in a smooth and positive way, the outcome can be rewarding for both buyer and seller. PER-SE Technologies, one of the largest healthcare information technology and business services companies recently completed the acquisition of Flexestaff, a Web based staffing, scheduling, and shift bidding software company.

PER-SE's Hospital Resource Management Solutions division provides a workforce management solution. That solution is installed in approximately 1100 hospitals. Flexestaff, on the other hand, was a two-year-old company with a cutting edge, high value solution, and a limited install base. The founders made one of the most difficult decisions that Entrepreneurs can make - to no longer go it alone.

Several factors contributed to this decision. First, the market discovered the value of this solution and several large players were beginning to focus resources on this space. A race for market share was beginning. Hospitals are generally risk adverse in their IT decision making - preferring an enterprise giant to an edgy start-up. That fact had Flexestaff stuck between the early adapters and broad market acceptance. After some encouraging initial success, the sales cycle began to lengthen.

Integration Risk - Another sales inhibitor was the customer's desire for this product to integrate with their existing resource management system. With scarce resources, that became a major hurdle for this young company. The founders used objective situational analysis and made the difficult, but correct decision to seek a strategic buyer.

Enter PER-SE Technologies. PER-SE was involved in a systems enhancement effort and their clients were responding favorably. Prior to this effort, product updates had lagged, limiting new account activity. This acquisition sent a clear message to the marketplace - we are committed to providing the best IT tools available and will acquire them when necessary. The sales force now has a new exciting product to offer to their installed accounts. They also have injected new energy into their prospecting efforts.

PER-SE management made a critical decision to buy rather than build. This is an enlightened attitude and in this case should pay huge dividends. Many large technology companies eliminate this key successful strategy by invoking the "not invented here" mantra.PER-SE Senior Management simply viewed the situation analytically rather than emotionally. A key factor that influenced this decision was the time to market issue. Of course, PER-SE could have developed the product themselves, but the time to market was estimated to be between 12 and 18 months. That simply was not acceptable to them given the current surge in the marketplace from their major competitors and a well-funded venture backed start-up. They weighed the opportunity cost of lost sales and perhaps some customer defections against the acquisition cost. Conclusion: getting this product to market now was imperative.

A second factor was that the cost to internally develop this offering was in the same range as the cost of the acquisition. The final determining factor for PER-SE was that they wanted the acquisition to be cash flow accretive. What that means is that PER-SE wanted the cash outflows comprising the transaction value to be offset by the gross profit margin produced by the new product sales.

Therefore, the deal structure became an important issue. If Flexestaff had insisted on an all cash at close deal, they would have limited their transaction value. By agreeing to a structure where a portion of the value was in cash at close and a meaningful portion was a generous earn out tied to future revenues, we dramatically improved the effective selling price. There is certainly risk associated with this approach for the seller, but the buyer was willing to compensate them for this risk. This allowed the buyer to meet their accretive acquisition requirement.

Let's project how the seller will fare. Over the next several years he will have one of the largest providers of Healthcare IT selling the product. Now 15 sales reps from the PER-SE division will be representing the product instead of the 2 sales reps pre-acquisition. Not only will these sales reps be calling on new accounts, but will also be calling on 1100 installed accounts using their product that fits beautifully with their acquired new product. It will be a relatively easy process to get existing customers to add on this new valuable capability.

Because the seller agreed to this risk sharing structure and the elements were favorable for explosive sales growth, the seller will most likely achieve a transaction value 70-100% above the original guaranteed transaction value. With a well-written contract, the seller will achieve outstanding total transaction value.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Friday, February 17, 2006

Shareholder Agreements Prevent Minority Shareholders

from Receiving Fair Value

Our Investment Banking firm is receiving an unusually high number of inquiries from minority interest shareholders looking for help. Often times they have just been terminated and concurrently receive a Letter of Intent to purchase their minority shareholder stock.

When they look at these offers, they are hit with their second punch in the gut. The offers are often woefully short of what the terminated shareholder expected. However, when they start to investigate, the harsh reality of the situation sets in. IRS Revenue Ruling 59-60 allows steep discounts when valuing minority interests in privately held companies. The lack of marketability discount can be as high as 40%. A second discount for lack of control for up to 40% can be applied on top of that.

Theoretically, if you owned 49.9999% of a company with a $10 million value and these maximum discounts were applied, your $5 million value evaporates into $800,000.

Wait, it gets worse. The oppressive shareholder understands that through either the shareholder agreement or the Corporate By Laws, they have every right to buy your minority stock at an even bigger discount from fair value. I cannot tell you how many times I have seen almost exactly the identical language as below in either By Laws or Shareholder Agreements:

Right of First Refusal: “The Corporation Shall have the power, at its option to purchase any and all of its shares owned and held by any shareholder who should desire to sell……the shareholders shall not assign, transfer, encumber, or in any manner dispose of any of all of the shares of the corporation that may now or hereafter be held or owned by them, and no such shares shall be transferable unless and until such shares have first been offered to the corporation.”

Wait, the pain is just beginning……. “In the event the Corporation exercises its right of first refusal under the above clauses, the purchase price shall be payable in cash or bank check, and shall be the book value of the shares, exclusive of goodwill, as of the first notice, as determined according to generally accepted accounting principles and shall be binding upon the parties.”

In most cases the “book value” of a company net of good will is a small fraction of the true value of the company. I looked at a company recently that had a market value of approximately $10 million. Its book value using this definition was approximately $800,000. A 40% shareholder wanted to sell his shares. According to the shareholder agreement, if, after he was terminated and given his bid from the oppressive shareholder of $500,000, he sought to sell his shares to an outside party, he would have triggered the Right of First Refusal clause. The result would have been a mandatory sale to the Corporation at a value of 40% of $800,000 or $320,000. This is not even close to the fair value of the company multiplied by his shareholder percentage.

Unfortunately, traditional legal remedies are inadequate to help these minority shareholders. Their attorneys are left with going after a wrongful termination lawsuit. Those end up being a frustrating and ineffective attempt to extract some measure of relief from this pain they are experiencing. The poor client will find it hard to win, he will spend the entire amount of a potential settlement on legal fees and most importantly, he is focusing on the lowest potential reward. His prize is in his stock. MidMarket Capital has worked with several clients in this area and has identified a number of successful strategies that are designed to achieve meaningful exits without legal conflict.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Friday, February 10, 2006

Contrary to what many sellers believe, an earn out component to a business sale is not necessarily a bad thing. As a business broker firm, we see the incidents of bad buyer behavior, but if properly used an earn out can be an excellent tool to maximize seller proceeds. First rule of earn outs – if you do not trust the buyer, there is not enough contractual language available to protect you. I will go one further. If you do not trust the buyer, do not do any kind of deal with him.If you are negotiating the sale of your business, you want an earn out to be structured so that if the guy you negotiated with and was the deal champion gets "hit by a truck’ his replacement can not interpret the agreement to your detriment. If you can, you want to have your earn out based on top line sales as opposed to division profits, for example. It is amazing how an overhead allocation from corporate can wipe out your division’s earnings.So once you have your earn out based on top line revenue are you safe? What if your company’s product were added to the acquirer’s suite or products? What if your product were used as a loss leader to help sell the other products? Just like that, your earn out revenue disappears. The way to protect yourself is to establish a minimum sales price for your product for purposes of your earn out calculation. You don’t want to try to dictate pricing to the new owner. You simply want to be given fair credit for the revenues that would have resulted had your product sold at historical levels.In spite of the risks, however, there are many reasons a seller would want to employ an earn out to maximize his business valuation. Here are a few:1. The seller has several big deals in the sales pipeline and wants to get paid for them. The buyer is going to heavily discount those forecasted deals if he is backed into an all cash at close structure. If the seller is willing to share the risk for those deals closing with an earn out component tied to the deals, the buyer will be much more generous. If the deals don’t close, it costs the buyer nothing. If they do close, he is happy to write you the earn out check.2. The seller anticipates that product sales will explode once the buying company integrates it with their distribution network. If the seller does not have strong sales or profits, but has a great product, it will be difficult to get the optimal selling price using historical sales and profit figures. Rather than take a low price based on those numbers, it may be better to bet on future performance and base a major component of transaction value on sales generated by the much larger company. Receiving 20% of a 10 times greater sales number as an earn out is a big win for the seller.3. An earn out can help bridge the value gap between buyer and seller and be the needed catalyst to getting the deal completed.The use of an earn out can be appropriate as a way for a seller to maximize his sales proceeds in the right circumstances. Just remember that the buyer champion that has established a relationship with you and is compelled to honor the intent of the earn out agreement will most likely be transferred or promoted before your earn out term is completed. You now are in the position of having this agreement interpreted by a person who has no connection or loyalty or knowledge of the intent or the agreement. His mode will be to interpret the agreement in a way to "minimize the expense of the future payment." Just make sure that interpretation cannot destroy the economics of the deal you originally negotiated.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

Saturday, February 04, 2006

If you can not resolve your business issues between a private company's share holders, one technique of resolution is called a Texas Shootout. Rember when you were a kid and there was one piece of cake left and both you and your sister wanted it? You got to cut the cake and she got to choose which piece. The same principal applies for the Texas Shoot Out. You sign an agreement to enter a Texas Shoot Out that basically stipulates that one shareholder will submit a bid to buy out the other shareholder. Let's say they were 50% each shareholders. The one receiving the offer could either sell his shares at the offer or buy the partners shares at the same price.Talk about high stakes poker. Sometimes this is the only fair way to resolve the issue.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

ARTICLE SUMMARY - Wall Street reported a banner year for Mergers and Acquisitions activity with corporate coffers bursting with excess cash. It seemed like every large company deployed this capital in one of three ways; a stock buy back, an increase in dividends, or an acquisition. All three activities represent a vote of confidence in the future growth of the economy. Nothing on the immediate horizon will interfere with this growth in 2006. How does this affect the owners of family businesses?

Wall Street reported a banner year for Mergers and Acquisitions activity with corporate coffers bursting with excess cash. It seemed like every large company deployed this capital in one of three ways; a stock buy back, an increase in dividends, or an acquisition. All three activities represent a vote of confidence in the future growth of the economy. Our economy has demonstrated incredible resilience in barely missing a beat during a series of devastating natural disasters and a huge run up in energy costs. Nothing on the immediate horizon will interfere with this growth in 2006. How does this affect the owners of family businesses?

We are just beginning the well-documented cycle of the retirement of the baby boomers. The baby boomers generation started and grew hundreds of thousands of successful privately held businesses. Those owners are facing retirement as well and are faced with the difficult decision of how to retire and exit their business. Having capable and well trained heirs involved in the business is the easiest exit. You combine gifting and buyout to achieve liquidity for the parents while allowing the next generation to continue the business. Statistics show that only one-third of all family businesses are successfully transferred to the next generation and only 13% are transferred onto the third generation. My feeling is that these percentages are decreasing over time. We therefore are entering the perfect storm for mid-market M&A from the supply side. Over the next 10 years we will see a huge increase in the available businesses for sale.

Economics 101 would tell us that with a glut of supply comes an erosion of prices. To the extent that your business is a commodity type, me-too, not differentiated, low margin business, you will be hard pressed to get aggressive multiples when you sell. That will be somewhat offset by the demand of larger companies in the same industry feeling optimistic about the economy and having available capital from profits to spend. Most industry roll-ups were entered with great promise, but for the most part were poorly executed. The buyers paid way too much in the feeding frenzy to grow market share – look at the waste management, electrical and HVAC, and equipment rental markets as examples of low performing roll-ups. The second major mistake was overestimating the synergies that should be achieved with size. The good news is that history is a good teacher and the industry consolidators are much better at it. You may not get an outrageous multiple, but you have a better chance of receiving future value from any portion of your deal that is in the form of company stock or performance based earn-out.

The good news is that attractive companies are very much in demand by both corporate buyers and Private Equity Groups. There is a lot of money waiting to be deployed. These folks with this money recognize what characteristics make a company attractive and may bid up the price in a competitive environment. Some of the characteristics they are looking for are unique market niche, barriers to entry, high margin, scalability of technology, proprietary technology, contractually recurring revenue, a strong management team and customer and product diversity. Grade your company in those areas. If you have some weaknesses, address them and your exit will be a lot more financially rewarding. 2006 will be a very good year to sell a strong company.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 davekauppi@midmarkcap.com or www.midmarkcap.comDave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

For Business Owners Seeking Strategic Value in Their Company Sale

Have you ever marveled at the prices at which some companies sell while most others sell at predictable valuation metrics. Much of this value creation secret is the result of "STRATEGIC ASSETS". These are assets that do not appear on a company balance sheet, yet they are hugely valuable to strategic industry buyers. This checklist will help you identify, nurture, and develop key drivers of transaction value for your eventual business sale.